Friday, February 12, 2010

Global Default

Niall Ferguson chimes in with an interesting look at the unfolding European Debt crisis:

It began in Athens. It is spreading to Lisbon and Madrid. But it would be a grave mistake to assume that the sovereign debt crisis that is unfolding will remain confined to the weaker eurozone economies. For this is more than just a Mediterranean problem with a farmyard acronym. It is a fiscal crisis of the western world. Its ramifications are far more profound than most investors currently appreciate.
He doesn't seem to think the US will escape, either:
For the world’s biggest economy, the US, the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the “safe haven” of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008.
Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase “safe haven”. US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.
The solution?  He reports on an IMF estimate that most of the developed economies of the world need to shrink federal expenditures on the order of 10% in order to return to sustainable footing.

Not likely to happen.  The government strains to keep the budget from growing from year to year.  I think it is safe to say that a 10% cut is politically impossible.  Markets can be tricky beasts with unpredictable behavior.  However, this crisis was completely predictable.  Default through inflation and/or some other form of debt repudiation is almost certain.

Be prepared.

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